Correlated risks, bivariate utility and optimal choices

Michel M. Denuit, Louis Eeckhoudt and Mario Menegatti
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Michel M. Denuit: UNIVERSITE CATHOLIQUE DE LOUVAIN,

No 2009007, LIDAM Discussion Papers CORE from Université catholique de Louvain, Center for Operations Research and Econometrics (CORE)

Abstract: In this paper, we consider a décision-maker facing a financial risk flanked by a background risk, possibly non-financial, such as health or environmental risk. A decision has to be made about the amount of an investment (in the financial dimension) resulting in a future benefit either in the same dimension (savings) or in the order dimension (environmental quality or health improvement). In the first case, we show that the optimal amount of savings decreases as the pair of risks increases in the bivariate increasing concave dominance rules of higher degrees which express the common preferences of all the decision-makers whose two-argument utility function possesses direct and cross derivatives fulfilling some specific requirements. Roughly speaking, the optimal amount of savings decreases as the two risks become "less positively correlated" or marginally improve in univariate stochastic dominance. In the second case, a similar conclusion on optimal investment is reached under alternative conditions on the derivatives of the utility function.

Keywords: bivariate higher order increasing concave stochastic dominance; precautionary savings; background risk; dependence (search for similar items in EconPapers)
Date: 2009-02-01
New Economics Papers: this item is included in nep-upt
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Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Correlated risks, bivariate utility and optimal choices (2011)
Working Paper: Correlated risks, bivariate utility and optimal choices (2011)
Working Paper: Correlated risks, bivariate utility and optimal choices (2011)
Working Paper: Correlated risks, bivariate utility and optimal choices (2011)
Working Paper: Correlated risks, bivariate utility and optimal choices (2010)
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